Question

A firm is expected to grow in perpetuity at a rate of 5%. If the current year free cash flow is 15 million, the cost of equity is 16%, after-tax cost of debt is 9% and the target debt to equity ratio is 0.25, then what is the value of this firm today if the tax rate is 20%?

Answer 1

Growth rate = 5%

FCF Current year = 15 Million

Debt to equity ratio = 0.25

Total capital = Debt + Equity

Debt = 0.25 * Equity

Total capital = 0.25 Equity + Equity

= 1.25 x Equity

Debt ratio = Debt / Total capital

= 0.25 / 1.25

= 20%

Equity ratio = 100% - 20% = 80%

Cost of equity = 16%

After tax cost of debt = 9%

WACC = Debt ratio * After tax cost of debt + Equity ratio * Cost of equity

= 0.20 * 0.09 + 0.80 * 0.16

= 14.60%

Value of the firm = Current FCF * (1 + Growth rate) / (WACC - Growth rate)

= 15000000 * (1 + 0.05) / (0.1460 - 0.05)

= 164062500